In August of 1919 Charles Ponzi in Boston received from an acquaintance in Italy
an International Postal Reply Coupon. These coupons had been created to
handle small international transactions. The recipients of such coupons
could exchange them in at their local post office for stamps. Ponzi noticed
that the coupon he had received from Italy had been purchased in Spain and
found that the reason for this was that the price in Spain was exceptionally
low. In fact, the cost of the International Postal Reply Coupon in Spain,
given the current exchange rate between the Spanish peseta and the dollar,
was only one sixth the value of the U.S. postage stamps it could be traded
for in the U.S. This seemed to be an extraordinary opportunity for arbitrage.

Ponzi envisioned a massive money making scheme in which dollars funds
would be converted into Spanish pesetas to use to purchase International
Postal Reply Coupons
which would be sent to the U.S. to be redeemed in U.S. postage stamps which
could then be sold for dollars. To Ponzi this seemed the opening to fast,
unlimited profits. The problem with the scheme was that if anyone began
to exploit the discrepancies in the prices of International
Postal Reply Coupons
in different countries the discrepancies would be corrected and the profit
opportunity would disappear.

Ponzi founded a company to exploit the profit opportunity in
International Postal Reply Coupons. Its name was The
Security and Exchange Company.
The Security and Exchange Commission (SEC) was not
founded until the 1930's so Ponzi was not trying to mislead potential
investors by giving his company a name similar to a Federal agency.

Ponzi circulated literature offering investors a 40 percent return in
ninety days. Since the prevailing interest rate was five percent per year
this was a very attractive offer. Ponzi's publicity was reaching primarily
the immigrant community of the North End of Boston, the community which
Ponzi himself was part of.

The investment in Ponzi's scheme began in small amounts in January of
1920. Ponzi then increased the promised rate of return to 100 percent on
ninety-day notes and 50 percent on forty-five-day notes. By February the
cash flow became a torrent. He had six clerks working constantly to take
in all the money. Ponzi deposited the money in a mutual savings bank.
A mutual savings bank is like a credit union in that depositors actually
buy shares in the organization. Ponzi soon became the major depositor/
share-holder of the bank and had himself elected president of the bank.

Ponzi was kept busy handling the money, acquiring properties and
enjoying a life of luxury. He was so busy with these things that he didn't
bother to exploit the discrepancies in the prices of
International Postal Reply Coupons. The only profit his organization was
making was the five percent interest on the bank deposits.

In July of 1920, the Boston Post published an article demonstrating
that the scheme was not financially possible. There were not enough
International Postal Reply Coupons sold to enable Ponzi to pay the returns
he promised.

Some investors came to Ponzi to take their money out of his scheme.
They were paid off with checks written on Hanover Trust Bank, a bank that
Ponzi had acquired control of. Ponzi however convinced many that the
Boston Post article was irrelevant because he had another, secret
scheme for making money that was better than the International Postal
Reply Coupon scheme. Ponzi was so convincing that instead of a run
on the Security and Exchange Company it had a net gain of two hundred
thousand dollars in investment.

A more serious threat arose when the District Attorney of Boston
ordered that Ponzi's Security and Exchange Company must stop taking
new investment until there was an audit of the firm's books. There was
another run on the Security and Exchange Company. The Boston Post
published another article based upon the revelations of a former publicity
man of Ponzi's. The publicity man charged that Ponzi was in debt
millions of dollars and asked why Ponzi was depositing funds in a
bank earning five percent interest a year when he supposedly had means
of making profits in excess of 50 percent in forty five days.

The Boston Post reporters then discovered Ponzi's past. He
was born in Italy but raised in Montreal, Canada. As a young man he
had been involved with arranging money transfers by Italian immigrants
to their families back in Italy. There were charges that some of the
remittances never arrived. In Montreal Ponzi had been sent to prison
for forging signatures to checks. After he was released from prison
in Montreal he migrated to Boston where he worked at menial jobs
such as washing dishes and clerking until 1919 when he found out about
the International Postal Reply Coupons.

The newspaper articles and the audit of Ponzi's Security and Exchange Company
destroyed the scheme. The Massachusetts State Banking Commission closed
down Hanover Trust, the mutual savings bank Ponzi was president of, but
not before Ponzi took about one million dollars to a Boston racetrack
to bet on some long shots in hope of winning enough to make his company
solvent.

When Ponzi was charged with grand larceny and using the mails to
defraud he told his public that all of his troubles came from the
fact that the wealthy were trying to punish him for giving the
"little guys" the opportunity to make a high rate of return. Ponzi was
sent to prison but released on parole after three and a half years.

While on parole Ponzi was rearrested. He then jumped bail and went
to Florida living under a different name. In Florida he was again sent
to jail for a real estate fraud in which he was promising a 200 percent
return in sixty days. He again jumped bail but was recaptured and
extradited to Massachusetts where he was sent to prison for another
seven years. When released from prison he was deported to Italy. In
Italy he got a job with the Italian Airline Alitalia where he worked
in Rio de Janeiro until the airline closed its Brazilian operation
during World War II. Charles Ponzi tried various jobs such as teaching
English but was not successful. He died in a charity ward in Rio de
Janeiro.

Although a flood of money during the early phases of a Ponzi scheme
may mislead people into thinking the scheme can succeed, a few simple
calculations show the impossibility of its financial survival. Consider
a transaction in Ponzi's Boston operation. His organization was taking
money and promising to pay 50 percent in forty five days or 100 percent
in ninety days. When the organization took in $100 for the ninety-day
version it incurred an obligation to pay $200 in ninety days. The way
to compare $100 now and the $200 in ninety days is to calculate the
present value of the $200 ninety days from now. The discount rate that
should be applied is the current market interest rate of five percent
per year. The present value of $200 discounted ninety days at 5 percent annual
interest is $197.53. Thus the net gain for the Ponzi organization on
a $100 accepted was (+$100-$197.53=) -$97.53. That is to say, the Ponzi
company lost $97.53 on every $100 of investment it accepted. Clearly the
more money it took in the farther in debt it became and so there is no
way the Ponzi scheme could get into the black by losing money on every
transaction.